A Tax Cut That Bleeds Revenue and Penalizes Work

Chuck Sheketoff

In eras past, doctors routinely bled patients in an effort to cure them. Fortunately, the medical profession eventually recognized that bloodletting actually made patients worse.

In the field of economic policy, however, an idea akin to bloodletting retains faithful adherents. That misguided idea argues that cutting the income tax on capital gains creates jobs and prosperity.

For the good of Oregonians, let’s hope that the 2011 legislature ignores the bloodletting call. Cutting the income tax on capital gains, as some in the business community are lobbying for, would not create jobs. Rather, it would bleed state revenue that pays for education, health care and public safety — structures that are essential for a good business climate.

A capital gain is income generated when assets such as stocks, bonds and real estate are sold at a profit. Right now Oregon treats people who earn their income from work the same as those who have income from capital gains.

Because the wealthy disproportionately own capital assets, giving capital gains a favored tax status would mostly benefit the fortunate few. Last time the Oregon Center for Public Policy crunched the numbers, we calculated that if Oregon slashed the tax rate for capital gains, the richest 1 percent would bank 70 percent of the money.

In addition, the proposal to give favored status to capital gains would leave many Oregonians who work for a living — who earn a paycheck to put food on the table — paying a higher income tax rate than those who live off their investments. Put another way, it creates a work penalty.

Some might say, “So what, if it creates jobs?”

Yet, as numerous studies have shown, cutting taxes on income from capital gains will not stimulate the economy or create jobs, especially at the state level. There’s no guarantee that the tax savings by Oregon’s millionaires would be reinvested in our state rather than invested in some other state, or handed over to a Wall Street hedge fund or invested in the Shanghai stock market.

“But,” some might ask, “what if we limit the tax cut to capital gains income that is reinvested in Oregon?”

Done that; didn’t work. From 1996 until the law expired in 1999, the legislature allowed investors to defer state income taxes on capital gains if the gains were reinvested in Oregon businesses. But an official review of the program (PDF) concluded that it failed to increase investment in Oregon, that much of the investment that did occur “probably would have occurred even without the deferral” and that the favored status “created few, if any, new jobs.”

The fact is that the current system — which doesn’t penalize work by favoring capital gains — is no impediment to investment and growth in our state. Oregon startup businesses are attracting venture capital. Businesses are moving here and (think “Intel”) are expanding.

It’s also a fact that Oregon’s economic growth has far outpaced the national average under current law without the proposed work penalty. From 2001 to 2009, Oregon’s Gross State Product increased by nearly 34 percent after taking inflation into account, more than double the nation’s GDP growth.

Of course, the Great Recession hammered Oregon and the nation’s economy, causing sharp revenue drops in nearly all states.

Oregon’s fiscal situation would worsen if lawmakers were to give favored status to capital gains. The business-backed work penalty would bleed revenue that’s essential to providing the public services that make Oregon a great place to work, raise a family and grow a business.

The 2011 legislature should reject the business community’s call to cut the income tax on capital gains, which would only bleed more revenue without creating jobs. We should continue to treat income from capital gains the same as income from work.


Oregon Center for Public PolicyChuck Sheketoff is the executive director of the Oregon Center for Public Policy. You can sign up to receive email notification of OCPP materials at www.ocpp.org.

Comments

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    I always hear the argument on BO that the rich fail to create jobs and investment, especially after tax cuts take place. Any specific numbers or evidence to prove that?

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    Chuck, thanks for a clear explanation of what amounts to another 'holy grail' for some. I would add that there are provisions in the latest tax package passed by Congress that Oregon should not follow and adopt without thorough discussion and review. And they should be reviewed under a clear, strong magnifying glass...

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    Numerous writers here have asked time and again for specific cases of businesses that have moved out of Oregon because of measure 67. Well, how about 10,000 specific cases of high-income individuals who have left the state because of measure 66 (the increase on personal income tax rates in joint returns with income over $250,000). The state was surprised to find that in 2009, there were 10,000 fewer returns filed by such indiciduals than the state expected. Check in Washington, Wyoming and Texas to find where they went. Chuck, you can keep asserting that Oregon's super-high capital gains rate is good, but the unemployment rate and out-migration of high income taxpayers are a strong argument against your position.

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      Have the 10,000 left the state or are they filing in a lower tax bracket?

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        Good question. Let's not forget that Oregon's per capita income is 90 percent of the national average; 75 in rural areas. (Which makes no sense to me juxtaposed with the state's alleged growth figures Mr. Sheketoff cited.)

        Mr. Wiggins forgot Nevada as another tax-refuge destination.

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        Lower bracket. No evidence of leaving the state...and how could they have left the state retroactively!?!?

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        The income of the wealthy goes down in tough economies.

        http://online.wsj.com/article/SB10001424052748703581204576033861522959234.html?mod=WSJ_newsreel_opinion

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      Loved that one Bob. State the issue: Businesses that have left Oregon due to M-67...Crickets, crickets, crickets..... Pivot: Individuals who allegedly have left the state due to M-66.

      So where is the evidence of those fleeing businesses? Never mind, just brought that into the discussion becuase......

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        Pat, there haven't been any official statements yet on the impact of 67 on business out-migration. The recent news was on the personal side. When there's some news on the business side, I'll add my two cents.

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      Bob, once again you let me down.

      The numbers you are referring to appear to come from the Wall Street Journal and Cascade Policy Institute's misunderstanding of numbers that the Legislative Revenue Office released last week.

      Yes, there are fewer affected tax returns than projected, but that does NOT mean there was migration. Aside from the fact that people can't move retroactively, it just reflects what LRO showed -- capital gains took a drop as total income dropped more than expected back in May 2009 -- in other words, the recession was deeper than they expected.

      In fact, there were more total taxpayers than projected!

      To suggest the LRO numbers show causation would be like saying that because global temperatures have increased while the number of pirates has declined is proof that the decline of piracy caused global warming.

      There are other holes in the WSJ piece. For instance, they say "Successful entrepreneurs like Nike owner Phil Knight don't get rich by being fools with their money. They don't sell tens of millions of dollars of assets when capital gains taxes go up." Yet they ignore the reality that as the tax measures were pending Phil did just that.

      Bob, you presumably have capital gains and haven't migrated yet, have you? Just checking.

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    "The economy affects politics, more so than politics affects the economy."

    I think it's extremely simplistic for anyone to blame one party - or one President - for the economic hardships we are enduring. There are so many other factors that play into economics besides tax policy.

    Of the two articles I read that you posted, none of them address these economic issues that impacted us over the past 10+ years:

    1. Manufacturing output down
    2. Increase of off-shoring
    3. Housing decline
    4. 9/11 and following recession
    5. dot com bust
    6. War on terrorism
    7. lack of access to credit

    In my opinion, all of these had a direct impact on the economy and on the decline in incomes more so than direct tax policy by Bush.

    M.I.T. researcher, David L. Birch, provided the initial evidence of the small business jobs phenomenon in The Job Generation Process. Small businesses create a vastly disproportionate share of the net new jobs in the United States.

    Why do I bring this up? According to the SBA, about 50% of small businesses go to traditional lending institutions for financing, while the rest rely on outside sources, like VC's, Angel investors, etc. These are wealthy people who are more likely to take a risk on a start-up or young business than a traditional lending institution.

    http://www.sba.gov/advocacy/851/12125

    This report by the SBA actually shows an increase in small business job growth from 1998 to 2007 (and their incomes increased, too). So I don't buy the notion that the last 10-years have been void of job growth, or that Bush's tax policy alone led to a decline in incomes and job creation.

    A report by the SBA Office of Advocacy found this:

    1. Commercial banks have become less important lenders for small business borrowers from 1993 to 2003; An Examination of Financial Patterns 41 Haynes and Brown
    2. Non-depository lenders, especially finance companies, have become more important lenders for small business borrowers from 1993 to 2003; and
    3. Commercial banks and finance companies (and other non-depository lenders) are more likely to have a complementary relationship vis-a-vis small business borrowers in 2003 than 1993.

    The wealthy in our country play a vital role in job creation on a number of fronts, especially in small business investing (which is the number one job creator in America).

    Money was too easy for all of us through the 2000's, and we're now dealing with the consequences of that, which has nothing to do with tax policy. It's difficult for small businesses to get access to capital, and therefore create jobs.

    Once that credit freeze begins to thaw, I believe there exists a lot of momentum for small businesses, which means we need to assure that businesses can access money at all levels: banks, finance companies, lines of credit, VC's, Angels, etc.

    I, too, want a fair tax policy, but always railing against the rich seems to be poisoning the well, so to speak.

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      The Bloomberg article is inferring that investment by the "rich" is not tax driven, but "health of economy" driven. Good economy = high levels of investment. Bad economy = cash hoarding.

      If that's the case, I see little reason to continue to give them tax breaks they don't need.

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